The entire world presently is fixated with the Eurozone’s financial struggles, and, for ample reason. Will this currency union of 17 nations collapse? Will some European countries default on their debt? Could a group of countries emerge in a fiscal union with a “new euro”? The consequences of a break-up of the Eurozone are truly dire. Why? For quite a number of reasons, but the most contagious of these being that numerous banks would collapse.
Should this occur, it would ripple out to the entire world financial system in a matter of nanoseconds. Credit markets would again seize up, contributing to another Great Recession … if not worse. The fact is that perhaps hundreds of banks (including some of the largest in the world) are already technically insolvent. It explains why key central banks are working together to ensure that no major banks get pushed to the wall should their funding dry up. On November 30th, the central banks of five key nations (U.S., Japan, Canada, UK Switzerland) together with the European Central Bank (ECB) announced joint actions to backstop the liquidity requirements of the European banking sector.
With the threat of potential bankruptcies, it only follows that investors are pulling their money out of European banking paper. As these banks roll over their debts (when they come due) they find that there are no takers for their new debt. That’s were the central banks come in.
Debates are raging as to what could be done to alleviate Europe’s financial problems. What makes the situation all so much more dangerous and dooming than the first stage of Global Financial Crisis (GFC … a term we have continued to use as we never believed that the GFC had ended), is that Ground Zero is now found in the sovereign government bonds of nations in the world’s rich club.
Whereas much of the blame for the first stage of the GFC (which began back in early 2008) was pinned on over-valued real estate securities and Wall Street alchemy, this time it is in an asset-type that is supposed to be a risk-free — namely government bonds of O.E.C.D. (Organization of Economic Cooperation and Development) nations.
Of course, nothing is entirely risk free. However, the world’s financial system has been built upon the throne of O.E.C.D. debt. For the purposes of regulating bank’s reserve ratios, these bond holdings are considered risk-free. Yes, it is government debt, not savings nor gold nor anything else tangible that underpins the value of money and the world’s financial system. And, now the very heart and core of this system has been shown to be subject to massive collapse.
You couldn’t dream up a more lethal coronary for the world’s financial system.
This dire situation now ushers in an era of complete lawlessness. Of course, aspects of the financial dislocations that have unfolded to date have always involved greed and corruption at various levels. As such, these developments have therefore been against the intent of the original laws and regulatory structure. In this sense, lawlessness is not new. But, no one imagined back in the days when global financial systems were formalized under the auspices of the Bank of International Settlements that an O.E.C.D. nation could ever go bankrupt!
While it is true that no O.E.C.D nation has yet officially defaulted (not evenGreece nor Ireland), the value of their government bonds have disintegrated. Banks who hold these securities will have incurred losses of as much as 50% and more. As such, O.E.C.D. debt — the core of modern-day wealth — has grossly failed.
That means that the rule of law is now conveniently put aside for what is deemed to be the “greater good.” For example, the terms of credit default insurance have been ignored in order that the credit write-downs and restructuring of Greece’s government bonds would not be considered a technical default. Everybody knows that Greece has effectively defaulted on some of its debts. But not officially. Were that the case, perhaps trillions of dollars of default insurance would have been triggered, the realization of which would have abruptly caused the collapse of numerous other financial institutions.
Of course, almost no one wants to see financial markets collapse and economies to crash into a nuclear winter of economic depression. As such, all of this gerrymandering and rigging is overlooked. In the end, none of these and other financial manipulations by policymakers will succeed in solving the fundamental causes of the current crisis.
The basic problem is very simple to understand. Imbalances amongst European nations have become so extreme, that the fundamental creditworthiness of some nations has deteriorated to the point that their government bonds have collapsed in value. This in turn is hugely destructive for the capital base of banks and other financial institutions. Even while such countries as Germany andSwitzerland and a few others have prospered with large structural trade surpluses, others such as Greece, France, Italy and others have run large and chronic deficits. One condition is the mirror image of the other. For one nation to be in surplus, another must be in deficit. But, understandably, when this imbalance becomes chronic, it is not sustainable and will end up in disaster. This is indeed what has happened.
Looking ahead, what can we conclude? For one, the current situation is extremely dangerous. There is no telling how things will unfold. The fact is that there are no immediate and easy solutions. It is a difficult, plodding road back to honest balance. This would involve the repayment of loans and/or the writing off or forgiveness of debts. For example, one recent study estimated that approximately $15 trillion in debt forgiveness would be required were Americaand Europe to reduce their total debt levels to a manageable 180% of GDP. Could this ever happen? Would the capital holders, the rich, the powers of this age allow this? You be the judge.
Despite the fact that all market participants around the world should now well understand that unsustainable, non-self-supporting trends must come to an end, we should not be surprised if short-term shenanigans continue. That the GFC even occurred is proof of this message.
The key question of the moment is this: Will the solution to current troubles be real and cooperative, or will an uncontrolled disaster unfold? Hollow, bogus policy actions will not work. We anticipate that, eventually, a patchwork of countries will be cobbled together into a new financial union. Initially, this would comprise only European nations.
But this likely will not be the end of the transition One must recognize that none of this can happen without the aid and approval of America and other non-European nations. If it wasn’t for the massive swap facilities extended byAmerica’s Federal Reserve, Europe’s financial system today would already have imploded. In any case, any type of union such as we surmise will only happen with a further escalating crisis. Things are not yet critical enough for such measures to come to implementation. When it finally does, it will be a arrangement that will also not last. If so, perhaps only for “one hour” (Revelation 17:12).
As a final conclusion, the same problems that applied to Europe could next affect America. It is also caught in a similarly imbalanced situation. It is running huge deficits (both in its government budgets and externally on its trade accounts). At some point, the world’s attention will again be turned to the financial deterioration of America. Then, U.S sovereign bonds will no longer be so popular.